Retirement Savings Vehicles Explained

retirement sign blue cloudsPutting money away for your future. It’s not the sexiest topic around, nor is it something many people think about before we turn 40. Why is that? Perhaps we don’t consider retirement to be so pressing at that age and we have other things on our minds that are far more important.

It’s true that many of us may work for employers who offer 401(k)s, and we begrudgingly deposit a portion of our paycheck into those accounts.  However, too many of us aren’t even taking full advantage of maximizing what we could be putting away each month.

Retirement isn’t at the forefront of our minds for any number of possible reasons, the most prevalent being that there are so many retirement savings options available and how they each operate can be somewhat confusing. Let’s face it, saving takes hard work and the first step is knowing all the ways to accomplish your goals.

You’ve likely heard of some already: Roth IRA, mutual fund, and 401(k).  These are just a few of the options you have for putting away enough money to live comfortably once you retire. There are others you can explore, too, to get the most out bang for your buck. You’ll just want to have the right information to assist you in making the best decisions for your personal goals and long-term fiscal outlook.

Smart, effective money management requires good research. That’s where this handy guide comes in.

Once you decide it’s time to put a greater focus on your future you’re going to need to find out all of the factors that come into play when you start saving. If you’re not careful, your hard-earned money can be whittled away by fees, taxes, penalties, and less than favorable rates.

We’re not going to let that happen to you.  We’re going to explain all of the retirement savings vehicles that exist and how they work. This way you can make the smartest and most well-informed choices for putting away your hard-earned cash for your golden years.

The time is now. It’s a common fact that those individuals who start investing in their retirement earlier have more to live on later. It’s never too early to start thinking about your future and this guide will give you all the tools you need to put away as much as you can.

Your choices vary among funds and accounts. Many of you probably have your employer’s 401(k) as a primary saving account and that’s a very good way to get started. For some people that’s the foundation, but as they get older they seek out additional savings vehicles such as investment retirement accounts (IRAs) and Roth IRAs, which are very much like annuities funds but without the contribution limits.

We’re getting a bit ahead of ourselves here.  Let’s begin with the basics.

Start with Your 401(k)

A 401(k) is a plan for saving money that is funded by deductions taken from each payroll check, before taxes. That last part is important because your taxable income is reduced based on how much money you save.  This helps lower your taxes come April 15th.

However, if you wish to withdraw money from your 401(k) before you’re set to retire, then you will have to pay early withdrawal penalty fees along with taxes on those funds as they are considered income. That’s not something you’re going to want to do with a 401(k), however.  The whole purpose here is to accrue wealth for your retirement and the more you take out before that time, the less you’re going to have later on.

Many employers who offer 401(k)s will also match whatever you contribute to the fund, typically up to a certain limit. That means whatever you put in there, your employer will deposit the same as long as it doesn’t exceed the maximum.

Basically, you’re getting free money from your company just for contributing to your 401(k). So, for every $50 or so you put in, your employer will also chip in $50. Needless to say this is a great arrangement for anyone looking to get started on their retirement. Not every employer provides this perk, but those who do are affording their workforce some very helpful financial assistance for their future.

When strategizing your 401(k) plan you’re going to want to consider that matching contribution to get the most out of the arrangement. If you’re already making contributions based on the limits your employer already offers, then you’re on the right track. However, let’s think about how much you’re really contributing from your pay in those contributions.

In many cases, you could be depositing no more than 5% of your pay if you’re only basing your contributions on what your employer will match. Some employers could offer to match up to anywhere from 7% to 20% of your annual salary. Just keep in mind that while your employer has imposed a limit, you don’t necessarily have to deposit that percentage. It might behoove you to increase your contributions, particularly if you’re much older and want to grow that nest egg quicker.

That’s not the best plan of attack for everyone, of course. What works for you financially is based on your personal goals, your age, and the amount you can afford to put aside for retirement from each payroll check. Just remember, the IRS has a limit on what you can contribute each year and you’ll want to consider that number as well in your investment strategy.

The amount fluctuates each year for inflation and if you’re over the age of 50, you have the opportunity to extend your deposits through “catch-up contributions” which is an extension to the IRS limit affording you the ability to get your nest egg that much closer to your desired amount as you get older.

You may start to withdraw money from your 401(k) after you turn 59 and six months. You won’t incur any early withdrawal penalties after that point. Any withdrawals made prior to that will come with a penalty, except if you are age 55 or over and have lost your job or you are disabled.

Similar Types of Employer-Sponsored Plans

There are a variety of plans that are similar to 401(k)’s depending upon the type of organization for which you work. A 401(k) is typically offered by public and private for-profit corporations.

However, if you work for a tax-exempt or non-profit organization like a public school or college, a library, hospital, or a church, you’re likely to be offered a 403(b). Government employees at the state and local level are usually given 457 plans. Then there are Thrift Savings Plans which are given to federal civilian and uniformed service employees.

These all work in the same manner, but they may have specific contribution limits, employer-matching contributions, vesting schedules, and other factors that might differ from one another. These factors are typically based upon the type of plan and how it’s being offered to an employee.

It’s important to review your plan before you sign up for it. In every case, however, the contributions are made before taxes in order to limit your tax liability, yet there could be taxes or fees assessed to withdrawals from the account.

How These Funds Operate

A 401(k) is actually quite simple in the way it helps you save for your retirement. The money you contribute is invested as per an investment plan that is offered through the 401(k). The types of investments you’re placing your money into are often mutual funds made up of a variety of stocks, bonds, and other securities that bring a pool of money together from many different investors at one time. In the case of your 401(k), that pool of investors are you and your co-workers who work for the employer that is sponsoring the plan.

Unfortunately, the one drawback to this scenario is that you don’t have much control over which bonds, securities, and stocks make up the investment strategy of your 401(k). That is decided by your employer and thus your choices are limited.

Vesting Periods

Vesting means you have full ownership and control over the contributions you make to your 401(k). Employees will always be vested 100% for the funds they deposited into their accounts, while there may be vesting schedules when it comes to ownership on employer contributions and earnings that accrue. Those schedule can range from immediate vestment to a waiting period that must expire before you are fully vested in matching contributions.

Vesting schedules can often affect the money in your account, mainly if you end up leaving your current employer for another organization. Departing your company before you become fully vested could mean you lose some of the funds that were deposited through employer-matching contributions. Your own contributions would remain unaffected and you would retain that money. Not every 401(k) comes with these stipulations, so be sure to find out if these apply to your plan.

Rolling Over Your 401(k)

While we’re on the subject of leaving your employer, if that time comes, then you’re going to need to know what to do with your 401(k). Many plans allow you to keep the money in your previous employer’s 401(k), or you can transfer it to another account.

If you choose the latter, then you’re going to need to “rollover” your 401(k). The fund will stay in place after you leave, but you must decide what you plan to do with it after you leave. You could roll it over into a new 401(k) with your new employer or into an IRA or other approved retirement savings plan.

You won’t need to worry about paying any penalties, fees, or taxes that you might be subject to with early withdrawal because you’re not actually taking any money out of the fund. You’re merely transferring it from one account to another and nothing else changes, aside from what your new employer might offer in the way of matching contributions. If you’re not moving the money into another 401(k) but an IRA instead, you’re going to be afforded different benefits and advantages than you might receive from a typical employer-sponsored plan.

Nest EggThe Benefits of an IRA

An IRA differs from a 401(k) in that it gives you more control over the way your money is invested. While most 401(k)’s have a limited number of options in which to put your contributions, IRA’s offer more choices beyond just stocks, bonds, and securities. With an IRA you also have the ability to invest in those vehicles along with index funds, individual stocks and bonds, and even cash.

The sky is the limit with an IRA and you’re the one in charge of where your money goes. You’re also the one responsible for managing and diversifying your portfolio so you’re not too heavily invested in one area.

That’s not the only advantage to an IRA over a 401(k). You’ll find that many brokerage firms won’t impose a minimum deposit requirement on IRA accounts, you have a lot of online resources for managing the money in an IRA and you may not face the same fees and penalties for early withdrawal, either.

While you may end up paying up a 10% penalty in addition to applicable federal taxes on any funds withdrawn before you turn 60 years old, you could be exempt from those penalties dependent upon why you withdrew that money from the IRA. For example, you could be exempt if the money is put towards college tuition and up to $10,000 may be applied to the purchase of your first home without penalty.

IRA vs. Roth IRA

There’s an even greater distinction on how your money is managed and invested when you compare a traditional IRA to a Roth IRA. In some cases, a Roth IRA could prove more beneficial to investors because anyone can qualify for these plans regardless of age.  A traditional IRA, on the other hand, requires you to be under 70 years of age to invest.

Under the mandates for a traditional IRA you must begin to take your required minimum distributions (RMDs) once you reach age 70 and six months, with a Roth IRA you can leave the money in there for as long as you wish. This makes a Roth IRA the ideal way to pass your wealth on to your heirs or other inheritors. Even better, your beneficiaries won’t owe any income tax on withdrawals that come from the account and they have the ability to stretch out distributions over many years.

Withdrawing your money from a Roth IRA is also tax-free, as are the earnings you receive. However, your contributions are not tax-free. Those will be taxed as regular income when you put them in, which is a direct opposite to a traditional IRA where the money that goes in isn’t subject to tax, but the money that comes out will be taxed.

Property Ownership

Another smart way to increase the size of your nest egg is through owning property. Unfortunately, it’s not as easy as merely putting down a sizable amount of money for a purchase.  Property ownership brings with it a myriad of risks and pitfalls along with tremendous upside for reward. You and your initial capital are open to a variety of exposures and hazards that you’ll need to be fully aware of before you invest.

Perhaps the most pressing of these dangers is the potential for a downward shifting property value. This is actuated through factors such as location of the real estate in question, speculation on rental growth, even resale values in the area can have some influence.

In addition, there are the growing needs of prospective tenants to whom you may rent the property and any impacts previous tenants might have on it as well. Long-term damage could limit your potential for renting the property out which means you’re not making any income on it and you could end up having to spend money to fix those problems.

Laws on the books that govern community property ownership can also play a role in the amount you are able to save over time. There are nine states in the U.S. that require any property acquired by a married couple to be considered jointly owned by both parties from the start. The risks inherent to these laws play a role in the event that couple divorces or the marriage is annulled.

In these instances, the property is to be divided equally between the parties which can bring on more headaches related to where the money for the purchase originated from, chain of title problems where only one of the owners is listed on documents, and a variety of other obstacles that can arise based on the necessary requirements of each state.

However, for as many risks that come with owning real estate, the rewards can be just as great. It’s well worth the trouble if you’re able to successfully navigate the obstacles that can be put in front of you. As we’ve mentioned, property value can fluctuate dramatically which can be perilous but when the value rises.  It’s a pretty tremendous feeling to know you’ve made more money with just a few actions on your part.

For that to happen, you need to put in some time, effort, and capital to make the property more desirable to potential renters. The more luxurious it is, the more rent you can request be paid by tenants.

Tax breaks are also a component of property ownership as you can be eligible for tax deductions on any expenses made on the property.  There are also tax breaks for the interest applied to your mortgage or any other money you may need to borrow to put down for an initial investment in that real estate.

Red For Rent Real Estate Sign in Front of Beautiful House.Earning Passive Income

Most people who purchase property for ownership do so with the intention of renting it out to tenants. The revenue that comes in from this arrangement is known as “passive income” and it’s labeled as such because the owner does not play an active role in the property itself in order to generate that income.

The owner is passive in that they merely claim ownership but they don’t live there nor do they have much in the way of other direct dealings in the operation of the property itself aside from maintaining it to a standard for occupancy. Many owners often employ building managers to conduct the daily business that comes with rental properties, but not all of them take that step.

Don’t let the term fool you, though — passive income is hardly passive. If you’re buying a property to rent, you’re going to have more than your fair share of hard work ahead of you. You need money to make money and it’s no different with owning rental properties. You can make a lot of money by renting to tenants, but you have a lot of prep work to do beforehand.

It’s not just about making the property itself appealing, either.  You need to have effective advertising and outreach in order to get desirable tenants to come view the property and you’ll need to make sure everything is running smoothly in every property. When something breaks down or needs repair, that’s going to be your responsibility in most cases, and you’ll need to hire the proper people to handle these issues when they arise. And they will arise. You can bet on it.

The key to making a good passive income is to have reliable tenants renting out your property. Without them, the property is sitting empty and is not generating any revenue for you. That’s not good because it’s not bringing you any passive income. You could end up losing money for every month that your property sits vacant and unused. So if you’re thinking about getting into the rental game, be sure you’re well-equipped to have the property rented out for as long as possible.

Our Final Thoughts

These are just a few of the retirement savings vehicles that exist. There are others out there that might suit your situation far better. The options featured here are just some of the more popular investment opportunities that exist. Feel free to do further research in order to get the maximum savings for your retirement needs.

Just keep in mind that just about every investment strategy encompasses some modicum of risk and it’s going to require some patience and more than a little luck to see a return on your investments. More important, you’ll need to stay cognizant of the many trends that come with the stock market as some of these retirement options involve market participation.

There are other options that come with less risk and some that offer even more, often with substantially higher rewards. It’s up to you how much exposure you wish to take on in the pursuit of increasing your nest egg. A slow, steady long-term approach will be a safer bet than an aggressive strategy for quicker earnings in less time.

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